New chain on the block fundamentally changing the role of finance functions

BLOCKCHAIN and Bitcoin may sound like it belongs in the pantheon of hipster tat alongside Tinder, top knots and cereal cafés, but it is set to have an substantive impact on the finance function and audit.

And while most will have heard of Bitcoin and its dubious origins, it was the introduction of the Blockchain that curtailed what had hitherto been a boundless Wild West with a thriving black economy.

Blockchain is the underlying technology that Bitcoin is built upon, and at its most fundamental level functions as an enormous decentralised electronic ledger, or distributed ledger.

While Bitcoin spearheaded the first wave of interest in Blockchain – somewhat undermined by wildly fluctuating value and a host of legal and regulatory concerns – this new, second wave moves away from cryptocurrencies to wider, real-world applications.

When a transaction is made, it leaves an indelible mark on the Blockchain, which is updated in real time.

Of course, most financial transactions are about guaranteeing and tracking the movement of cash and assets from one ledger to another. In a peer-to-peer scenario, transactions take place directly, with no central, correct record of the data. It is therefore possible for fraud, error and data corruption to creep in.

This is where the Blockchain comes in. In the case of Bitcoin, its Blockchain – its public ledger – is strewn across millions of computers, keeping a reliable record of each transaction for little or no cost. There’s no middleman, no handling costs and the Blockchain provides authentication, immutable evidence of ownership, complete with history.

It’s this that differentiates Blockchain from simple bank servers. Servers, by and large have worked well. But, if servers were to fail – as they have been known to in the past – they may be unable to share the cash or unable to complete the transaction; something helpfully illustrated by RBS’s IT collapse in 2012, which saw customers unable to withdraw money and accounts frozen.

Blockchain’s capability has led to excitable comparisons with other great inventions of our times. EY’s UK head of assurance Hywel Ball said Blockchain “will do to corporate reporting and financial transactions what the internet did for knowledge. It could fundamentally change the role of the finance function and has huge implications for us as auditors.”

Businesses such as Everledger provide a good example. According to the firm, about £45bn is lost to insurance fraud annually in the US and Europe, and £100m paid out in jewellery theft claims. With that in mind, Everledger has created a distributed ledger of traceable luxury goods, particularly diamonds, offering verification for insurance companies, owners, claimants and law enforcement.

Banks getting together

Similarly, a consortium of banks calling themselves R3 CVE are investing in a private Blockchain in order to test the technology’s potential. In November last year, BNP Paribas, Wells Fargo, ING, MacQuarie and the Canadian Imperial Bank of Commerce joined the project which already boasted JPMorgan and Citi, led by New York-based financial tech firm R3.

Most of the world’s biggest banks – barring Chinese lenders – are now involved in the initiative.

“The R3 collaborative model is the best way to quickly, efficiently and cost effectively deliver these new technologies to global financial markets,” R3 CEO David Rutter told Reuters.

This model illustrates a more sophisticated step in the development of Blockchain. “Closed” or “permissioned” blockchains are increasingly used alongside their public cousins to address concerns about the transparency of openly-accessible ledgers.

Permissioned ledgers have the potential to address regulators’ worries over the abuse of cryptocurrencies by those attracted by its perceived lack of traceability. With adequate oversight, regulators could have far greater visibility over a more secure, and in many ways self-sufficient, market.

Potential barriers

There are, though, some serious challenges in the pipeline before Blockchain can become mainstream.

Its global nature, taking in various jurisdictions, poses a headache, while regulators are likely to defend the central banks it potentially threatens as intermediaries.

There are also reservations about the difficulty in reversing transactions. If you make a transfer in error using a traditional system, you can call up your bank and advise them of the mistake, and the error is dealt with. Under Blockchain, there is no such system and reversing the error is likely to prove troublesome at the very least.

Then there is the perennial issue of moving the discourse on and separating Bitcoin and Blockchain in the minds of stakeholders and the public. That, though, is more likely to take place as R3 CVE’s endeavours and other similar projects develop and mature.

“The consequence of Blockchain is this single source of truth,” EY’s Hywel Ball said. “For financial services firms, it reduces back office costs, you don’t need the same sort of intermediaries and it still adds a level of comfort because the principles themselves are held in the ledger.”